Hong Kong Fund Exemptions: OFC, LPF and Unified Profits Tax Exemption Regime

Hong Kong Fund Exemptions OFC LPF and Unified Exemption Regime

Hong Kong exempts investment funds from profits tax. The framework covers Open-ended Fund Companies, Limited Partnership Funds, and any other vehicle that meets the conditions in the unified exemption regime. The exemption is not automatic. A fund must satisfy a specific set of requirements codified in the Inland Revenue Ordinance (Cap. 112), and those requirements apply uniformly regardless of legal structure. Fund managers, investors and advisers need to know which conditions attach to which fund type, how the foreign-sourced income exemption regime interacts with the fund exemption, and where the territorial source principle draws the line.

Hong Kong Unified Fund Exemption

The unified fund exemption applies to two categories: "qualifying funds" under section 20AN of the Inland Revenue Ordinance, and "specified funds" under section 20AO. Both categories cover profits tax on transactions carried out by or through the fund, provided the fund meets the relevant conditions.

The dividing line is the investor spread requirement. A qualifying fund must have at least four investors, and no single investor may hold more than 75% of the fund's beneficial interests. A specified fund is one that fails that test but still qualifies for exemption because it satisfies an alternative condition: it is either regulated by the Securities and Futures Commission or authorised by the SFC as a collective investment scheme.

This unified regime replaced a patchwork of exemptions that applied separately to OFCs, LPFs and other structures. From the year of assessment 2019-20 onwards, the regime applies uniformly to all qualifying funds and specified funds, whatever their legal form.

OFC Tax Exemption Hong Kong

An Open-ended Fund Company is a company incorporated in Hong Kong under the Companies Ordinance (Cap. 622) and registered with the SFC as an OFC under the Securities and Futures Ordinance (Cap. 571). OFCs serve primarily as investment vehicles for collective investment schemes.

The profits tax exemption applies automatically if the OFC is a qualifying fund or a specified fund. It covers profits from qualifying transactions: dealings in securities, futures contracts, foreign exchange contracts, commodities, and other financial instruments specified by the Inland Revenue Ordinance. Incidental transactions ancillary to the fund's main investment activities are also covered.

Two further conditions apply. The OFC must not carry on any business in Hong Kong other than the business of making investments. And its central management and control must not be exercised in Hong Kong. That means the key strategic decisions about the fund's investments must be made outside the territory. The condition flows directly from the territorial source principle: Hong Kong taxes only profits arising in or derived from Hong Kong, and a fund whose central management and control is outside Hong Kong is generally not considered to be trading in Hong Kong.

The Inland Revenue Department sets out its approach in Departmental Interpretation and Practice Note 21 (DIPN 21). For OFCs, the IRD examines where investment decisions are made, where the fund's investment managers are located, and where the fund's investment committee meets. If those activities take place outside Hong Kong, the OFC's profits are likely to be sourced outside Hong Kong and therefore not chargeable to profits tax.

LPF Tax Exemption Hong Kong

A Limited Partnership Fund is registered in Hong Kong under the Limited Partnership Fund Ordinance (Cap. 637). LPFs are used primarily for private equity, venture capital and other alternative investment strategies.

The exemption follows the same unified regime. An LPF that is a qualifying fund or a specified fund is exempt from profits tax on its qualifying transactions. The conditions are identical: no business in Hong Kong other than making investments, and central management and control exercised outside Hong Kong.

The central management and control test demands particular attention for LPFs because the general partner is often located in Hong Kong. The IRD examines whether the general partner's investment decisions are made in Hong Kong or elsewhere. If the general partner delegates investment management to an offshore investment manager and does not itself exercise strategic control over the fund's investments from Hong Kong, the LPF may satisfy the condition.

The LPF structure offers flexibility on investor numbers. An LPF can have any number of partners, and no minimum investor spread requirement applies for the LPF to qualify as a qualifying fund. If the LPF does not meet the investor spread test, at least four investors with no single investor holding more than 75%, it may still be treated as a specified fund and qualify for the exemption if it is regulated by the SFC or authorised as a collective investment scheme.

Hong Kong Fund Profits Tax Exemption Conditions

The conditions are set out in sections 20AN and 20AO of the Inland Revenue Ordinance. They apply to all qualifying funds and specified funds, whether structured as OFCs, LPFs or other vehicles.

Condition 1: Qualifying transactions. The fund must carry out only qualifying transactions, defined in section 20AN(4). These include transactions in securities, futures contracts, foreign exchange contracts, commodities, and other financial instruments. Incidental transactions ancillary to the fund's main investment activities are permitted, provided they do not exceed a prescribed threshold.

Condition 2: No other business. The fund must not carry on any business in Hong Kong other than the business of making investments. Trading activities unrelated to the investment portfolio are prohibited.

Condition 3: Central management and control outside Hong Kong. The fund's central management and control must not be exercised in Hong Kong. The condition is satisfied if an investment manager located outside Hong Kong makes the fund's investment decisions and a board or committee that meets outside Hong Kong determines the fund's strategic direction.

Condition 4: Investor spread (for qualifying funds). The fund must have at least four investors. No single investor may hold more than 75% of the fund's beneficial interests. The condition prevents single-investor structures that are not genuine collective investment schemes from accessing the exemption.

Condition 5: Specified fund alternative. A fund that does not meet the investor spread condition may still qualify as a specified fund if it is regulated by the SFC or is a collective investment scheme authorised by the SFC. Specified funds are exempt from the investor spread requirement but must satisfy all other conditions.

Interaction with the FSIE Regime

The foreign-sourced income exemption regime took effect on 1 January 2023 and was expanded from 1 January 2024 to cover disposal gains. It applies to members of multinational enterprise groups that receive covered income in Hong Kong. For a fund managed by a global asset manager, the FSIE regime is directly relevant.

A fund that is a qualifying fund or a specified fund under the unified exemption regime is exempt from profits tax on its qualifying transactions, regardless of the FSIE regime. The two regimes operate independently. But if the fund receives income not covered by the unified exemption, interest income from a non-qualifying transaction, for example, the FSIE regime may apply if the fund is a member of a multinational group and the income is received in Hong Kong.

The FSIE regime requires the fund to satisfy one of the exceptions to avoid being chargeable to profits tax on the covered income. The principal exceptions are the economic substance requirement, the nexus requirement for intellectual property income, and the participation exemption. For funds that are not part of a multinational group, the FSIE regime does not apply, and the territorial source principle governs the tax treatment of non-exempt income.

Fund managers should review their fund structures. Any income not covered by the unified exemption must be either sourced outside Hong Kong, and therefore not chargeable under the territorial source principle, or fall within one of the FSIE exceptions. The IRD's guidance on the FSIE regime is set out in Departmental Interpretation and Practice Notes.

Practical Considerations for Fund Managers

Document central management and control. Maintain records showing where investment decisions are made, where investment committee meetings are held, and where the fund's strategic direction is determined. These records are critical for supporting a claim that central management and control is exercised outside Hong Kong.

Monitor the investor spread. For qualifying funds, monitor the investor spread at all times. If a single investor's holding exceeds 75%, the fund may lose its qualifying fund status and must rely on the specified fund alternative, which requires SFC regulation or authorisation.

Stick to qualifying transactions. Ensure that all transactions carried out by the fund are qualifying transactions or incidental transactions. Non-qualifying transactions may expose the fund to profits tax on those transactions.

Check the FSIE overlap. For funds that are part of a multinational group, assess whether any income not covered by the unified exemption is subject to the FSIE regime and, if so, whether an exception applies.

Prepare for IRD enquiries. The IRD may issue enquiries to funds claiming the exemption, particularly where the fund has a Hong Kong-based investment manager. Have supporting documentation ready.

The unified exemption regime provides a clear and consistent framework. Satisfy the conditions set out in the Inland Revenue Ordinance, and OFCs, LPFs and other qualifying funds achieve profits tax exemption on their investment activities.